Did you know that there were more cryptocurrency exchange hacks last year than in any other year before? According to blockchain analysis company Chainalysis, hackers breached eleven large cryptocurrency exchanges in 2019 stealing over $283 million in cryptocurrencies. The year prior hackers took home $875.5 million worth of crypto with only six attacks on major exchanges. In today’s fintech landscape security is more pertinent than ever before. Having a secure digital wallet is by far the most important thing you can do to protect your cryptocurrency. In this article, we will give background on digital wallets and explain the pros and cons of hot, cold, and warm wallets to give you a better understanding of how to keep your cryptocurrencies safe.
What is a digital wallet?
You need a digital wallet - or “blockchain wallet” - to own or trade cryptocurrencies.
A digital wallet is a software program that interacts with one or more blockchains and allows the user to send and receive digital currency.
In addition, it stores the user’s public and private keys and lets them monitor their account balance. Public keys are used to receive funds, identify accounts on the network, and can be searched for in the ledger. Private keys are used to sign transactions and prove the user owns the related public key. Guard your private key like your life depends on it because anyone who has it, can access your funds.
Digital wallets don’t ‘store’ currency like traditional ones. The ledger (blockchain) is the only record of ownership and it can only be accessed via a digital wallet. Remember that digital wallets are only pseudonymous. All transactions for cryptocurrencies are stored publicly (and permanently) on their respective blockchains. Data from your digital wallet address could be used to trace your real identity.
Read also: Is Cryptocurrency Anonymous? The Myth of Anonymity Debunked
Hot wallet definition and characteristics
The term “hot wallet” refers to a blockchain wallet that is connected to the internet. A hot wallet allows the user to store, send and receive crypto quickly and easily. There is always an inherent risk of holding cryptocurrencies in a hot wallet as hackers could exploit hidden vulnerabilities in your wallet’s software to access the internet-connected funds. It is a good security practice, recommended by cryptocurrency advisors, to only hold a minimal amount of crypto in a hot wallet as there is a rare chance of a breach. However, they are generally safe and convenient for frequent use of funds. Popular hot wallets include Coinbase and Blockchain.info.
Cold wallet definition and characteristics
“Cold wallet” refers to a digital wallet that is not connected to the internet. Being offline protects the cryptocurrency stored in a cold wallet from cyber attacks, unauthorized access and other vulnerabilities associated with being online. Due to the permanent nature of records on the blockchain, it is important that large sums of crypto be stored securely. A cold wallet is the best way to do this. A cold wallet can be on an encrypted external drive (called a hardware wallet) or even a code written on a piece of paper. In either case, the crypto inside the blockchain wallet is secure from internet-related attacks. However, it is more cumbersome to transfer crypto to and from a cold wallet than it is with a hot wallet. Another downside is that not all cryptocurrencies are compatible with cold wallets.
Warm wallet definition and characteristics
Warm wallets sit in between hot and cold wallets on the digital wallet spectrum. They have the seamless transaction capabilities of hot wallets paired with the security features of cold wallets.
One example of a popular type of warm wallet would be a hardware wallet. This dedicated device signs transactions and generates keys. It can access the blockchain via the internet. However, once disconnected from the internet a warm wallet has the same top-notch security features as a cold wallet. There is no way to access the funds without physical access to the device containing the hardware wallet. Transactions operate differently with warm wallets. When transferring crypto with a warm wallet you make an “intent to move” block that registers what you are about to do. There is a period of time during which the transaction can be canceled.
How to keep crypto wallet safe?
Any good crypto advisor will tell you that you should keep your digital wallets backed up. This can save you in the event of hardware failures, human error or even theft. If you keep your hardware wallet encrypted (and you definitely should) in the event it is stolen, the thieves will be unable to access your cryptocurrency and you still have access via your backups. When you do backup your digital wallet make sure to back up the entire thing. Some wallets utilize multiple obfuscated private keys internally. If your backup only includes private keys for visible bitcoin addresses you may be unable to recover all of your crypto from the backup. You should be making backups regularly.
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Finally, one good piece of advice is to avoid single points of failure. They’re bad for security. When your backup is not dependent on a single location it is less likely that one single catastrophic event will wipe out all chances to recover your funds.
In today’s age of ransomware attacks and the constant threat of hackers, security should be a top priority for everyone with a digital wallet. A digital wallet contains public and private keys and allows the user to send and receive cryptocurrencies. There are three types of digital wallets: hot wallets, cold wallets, and warm wallets. Hot wallets are always connected to the internet. They are the best place to keep small sums that are used in frequent transactions due to the ease of sending and receiving crypto via a hot wallet. Cold wallets are the only answer to the long term storage of large quantities of crypto (or small sums you want to keep under maximum security). Cold storage devices are not connected to the internet and therefore cannot be hacked except through physical access to the device (be that paper or hardware). Warm wallets combine the features of both hot and cold wallets. They allow the user to connect to the internet and perform transactions similar to a hot wallet while also becoming effectively a cold wallet when disconnected from the network. Make sure to follow good security practices like backing up your wallet and avoiding single points of failure.
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